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By John Nugent

The bitcoin logo (Photo credit: Wikipedia)

LONDON – Christmas came early for the Winklevii this year. Tyler and Cameron Winklevoss, the twin brothers who famously sued Facebook founder Mark Zuckerberg, own about 1% of the roughly 12 million bitcoins in circulation. Though its value has fluctuated considerably and continues to do so, the digital currency recently hit a high of $1,240, up from $13 a year ago – a more than 9000% increase.

Not everyone is sold on bitcoins as an investment. Detractors argue that bitcoins have little or no real-world utility outside transactions on online black markets. Earlier this month, former Dutch central bank president Nout Wellink compared rising bitcoin exchange rates to the Dutch tulip craze of the 17th century, during which the value of certain tulip bulbs rose to several multiples of workers’ annual wages before the price abruptly crashed. Indeed, most current bitcoin owners are believed to be speculators – estimates range from just over 50% to as high as 90% of the total. Sustained speculation may advance an upward price spiral, but bitcoin has already experienced several price readjustments in recent years. And it remains volatile: just three days after topping out over $1200 earlier this month, the currency plummeted to $650 after China banned its financial companies from handling bitcoin transactions, though the currency has rebounded somewhat since.

Even if bitcoin manages to survive a speculative bubble, capped circulation will ensure continued price rises, thereby promoting hoarding behavior that undermines bitcoin’s transactional utility. Evidence suggests that widespread ‘hoarding’ is not yet a major issue, given that the bitcoin cap is not expected to be reached until 2140. But it remains far from clear that a viable market based around bitcoins exists.

Advocates of bitcoins view the currency as having the potential to bring about a kind of financial revolution. They contend that the independence from the traditional banking system reduces transaction costs and the absence of government control insulates the currency from political tides. This has the potential to increase accessibility of basic financial services in impoverished nations, raise fund security, provide a means of circumventing strict capital controls in various countries, and enable the provision of assistance to oppressed individuals in repressive nations.

Of course, the absence of regulatory control makes bitcoins attractive to criminals as well. Bitcoin payment systems enable users to remain relatively anonymous and often retain no information on users; involve minimal fees; are accessible around the globe via the internet; feature irrevocable transactions; and facilitate the exploitation of cross-jurisdiction weaknesses in anti-money-laundering and counter-terrorist-financing regimes. That said, the bitcoin infrastructure has still not reached the point where it is capable of accommodating the massive single transfers of money involved in an individual large-scale money laundering operation, and it is unclear whether it ever will.

The growth in the value of bitcoins also makes them more attractive to cyber thieves, and incidents of theft are on the rise. Malware attempting to steal bitcoins or break into digital wallets is growing in prevalence. Cyber criminals are also using botnets to “mine” bitcoins. Mining is the process by which new bitcoins are released into circulation: bitcoin transactions are stored in a publicly viewable ledger known as the “blockchain,” which enables them to be verified. The blockchain is maintained, and transactions authenticated, by “miners” who use computers to solve cryptographic puzzles derived from the history of transactions. Miners are awarded bitcoins for solving these puzzles, which become exponentially more complex as the combined processing power being dedicated to the task of mining increases in order to ensure that the puzzles are solved, and thus bitcoins released, at a steady, predictable rate.

For investors and businesses looking to do business in bitcoins, some basic security measures can help safeguard investments. One is to put an “air gap” between one’s bitcoins and the internet by creating an offline wallet. Encrypting the contents of a wallet is another basic step, as is using multiple wallets with smaller sums stored in each.

An earlier version of this article incorrectly stated that miners generate bitcoins by solving algorithms, and that these become increasingly complex with the circulation of additional bitcoins. Miners are awarded bitcoins for solving mathematical puzzles and their increased complexity is a result of the growth of the combined processing power being dedicated to their resolution.